What are Accounts Receivable Loans?

What are Accounts Receivable Loans? | Accounting Smarts
Charles Hall

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Charles Hall

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March 1, 2021

An accounts receivable loan is a financing method used by small businesses to obtain funds immediately by using their accounts receivable as collateral.

An accounts receivable loan is a financing method used by small businesses to obtain funds immediately by using their accounts receivable as collateral. A company is able to access the money earlier than waiting the 30 to 60 days to collect from customers. These funds are provided by a third-party company, who specializes in accounts receivable financing.

Because cash flow is critical in operating a business, the accounts receivable financing option may be a good choice. It offers access of up to 100% of the small business accounts receivable, and can be treated almost like a line of credit, meaning the process can be repeated over and over as new receivables are created.

There is typically a 1 to 5% fee associated with this type of financing.

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How does accounts receivable financing work?

The process is rather simple. Here is a step by step guide to help you understand the process and get you started.

1. Find an accounts receivable financing company

This might be the hardest step, particularly if you are new to this type of financing. No fear, here are 5 accounts receivable financing companies you can explore. There are many others but these are some to get you started.

Crestmark – they will advance up to 90% of your receivables and their rate is not specified.

Payability – they will advance up to 85% of your receivables and their rate is 1% per month. If you sign up through this link, you'll get a $250 sign on bonus.

BlueVine – they will advance up to 90$ of your receivable and their rate is .25% per week

Paragonfinancial – they will advance up to 90% and their rate is less than 1.5% per month

Lendingtree – they have not disclosed their terms, but it is a known name in the lending industry

2. Setup a new account

Once you have chosen a financing company you will setup an account. Each company will have a slightly different process but most will perform the following due diligence to make sure your company is eligible for the program.

  • review your customer profiles
  • review your customer receivables aging report
  • review your corporate tax returns
  • review all business owners of your company
  • review there are no liens outstanding against your receivables.
  • review your company financials

This provides you a checklist to review prior to contacting the financing company to ensure you have everything in order. Once the due diligence is done, and no issue exists your account can be set up.

3. Prepare your receivables

You know your accounts receivables best, and while you are seeking financing you don’t have to submit all receivables. So, it will be advantageous to review all your customers and the corresponding receivables and identify those that will be included. If you have a list prior to contacting the financing company the approval process will go much better. Remember the goal is collection, so you would only want to submit those receivables that are likely to be collected and fall within the 30-60-day categories.

4. Verification of your receivables

Once the financing company has your list of receivables, they will independently verify them to ensure goods and services have been delivered. It also minimizes any problems down the road.

5. Receive the advance funds

After the financing company has verified the receivables and everything is in order, they will fund or distribute the money to your bank account. Remember that the advance will equal the percentage, per the contract, times the balance of the receivables submitted. While there may be a financing company that funds 100%, it is most likely it will be funded at 85-90%. The funding process should only take 1-2 days.

6. Settling your account

Once everything is in place, customers will pay their invoices either by mail or electronic transfer to a location specified which could be a lock box or a specific bank account. The financing company will have access to either. Once all the receivables are collected, the financing company will return the percentage that was not included in the advance less any financing fees charged.

The process is relatively simple, and once you have its setup and functioning, it is easy to repeat over and over again. There is no restriction on the use of the advanced cash received as it can be used for paying normal operating expenses or new growth opportunities.

Why should I consider accounts receivable financing?

  • If cash flow is a problem, this is a way to manage it
  • It is fast, both in terms of approvals and funding
  • Balances the peaks and valleys of your cash flow
  • You remain in control, and the paperwork is minimal
  • Customers are typically unaware of the process
  • You can terminate at any point if you no longer need the financing

The only real negative is it may be a little more expensive than other financing options, but if it is the only option then it is probably a good option.

What happens if customers don’t pay the accounts receivables?

While this is a possible outcome, the risk is much lower than you may think. The accounts receivable financing company thoroughly vets the accounts receivables that are submitted mitigating the risk of nonpayment. However, there are mitigating factors like disasters or other issues that could arise and cause nonpayment. Under these circumstances there are 3 courses of action.

Typically, in the contract with the accounts receivable financing company it will clearly state who takes responsibility for nonpayment. Here are the options:

  • Recourse option

if your customer does not pay, you become responsible for the payment. The financing company has already advanced you the money so you would have to pay them back for that portion.

  • Non-recourse option

Under this option, the financing company takes responsibility regardless if the customer fails to pay. However, because the risk is higher to the financing company the fees will reflect that risk and be higher to you.

  • Modified recourse option

Under this option, the financing company secures insurance against nonpayment therefore they bear the responsibility. However, insurance does not cover all scenarios so you may still have some responsibility, and your fees will be higher.

What is the difference between accounts receivable financing vs factoring?

While the majority of this article has addressed accounts receivable financing, there is another financing method called accounts receivable factoring. The terms may be used interchangeably, but there are a few differences.

Financing

Under the financing method, accounts receivables continue to belong to you, and are only used as collateral for the advance funding. Because of this you continue to work directly with your customers and push for collection.

Factory

Under the factoring method, accounts receivables are actually sold to the financing company, the determine which receivables they will finance and they are in charge of collecting from the customer.

Does bad credit affect accounts receivable financing?

The great news is NO, bad credit does not affect accounts receivable financing. The main reason is the receivables are securing the funding. The only part bad credit may affect is the percentage the financing company will finance. This will all be sorted out in the initial due diligence.

Charles Hall

Charles Hall

Charles has spent 25 plus years in the world of accounting and business. His experience includes working as a CPA/Auditor international accounting firms. He has worked as a controller and as a COO for small to medium sized companies.

Learn more about Charles Hall